The RBA Quietly Admits Responsibility for Bubbly House Prices

Jonathan Rochford

Narrow Road Capital

This week the RBA quietly admitted that low interest rates have played a big part in the rise in Australian house prices. This comes after years of denying the obvious. I say quietly admitted as it came in a “research discussion paper” on its website written by two of its economists. The older of the two is in his 50’s and has worked in Treasury, at the OECD and at the US Fed over his career. Here’s the summary of the paper:

We build an empirical model of the Australian housing market that quantifies interrelationships between construction, vacancies, rents and prices. We find that low interest rates (partly reflecting lower world long-term rates) explain much of the rapid growth in housing prices and construction over the past few years. Another demand factor, high immigration, also helps explain the tight housing market and rapid growth in rents in the late 2000s. A large part of the effect of interest rates on dwelling investment, and hence GDP, works through housing prices.

In the introduction they note the following key relationships for housing:

  1. Interest rates, income and housing prices have strong and clear effects on residential construction
  2. Dwelling completions and changes in population explain the rental vacancy rate
  3. The vacancy rate has a strong and clear effect on rents
  4. Interest rates, rents and momentum have large effects on housing prices
  5. Housing prices and construction are mutually determined, so examining bivariate relationships in isolation can be misleading.

None of this would be surprising to someone who has observed the reactions of ordinary people (or the population as a group) to changing circumstances. But for economists who tend not to work with the real world so much this stuff is a revelation.

Note that the summary mentions lower world long-term rates, rather than directly attributing higher Australian house prices to lower Australian rates. I think that deflection may have been required to get this published as an RBA paper. However, it is clearly left open for people to read between the lines, that the RBA is mostly responsible for the house price growth in 2015-2017. With the benefit of hindsight, the RBA might have some regret over the four rate cuts in 2015 and 2016 that took Australian prices from overvalued to bubbly.

Jonathan Rochford
Portfolio Manager
Narrow Road Capital

Narrow Road Capital is a credit manager with a track record of higher returns and lower fees on Australian credit investments. Clients include institutions, not for profits and family offices.

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